Academic journal article Journal of Real Estate Portfolio Management

Changes in REIT Stock Prices, Trading Volume and Institutional Ownership Resulting from S&P REIT Index Changes

Academic journal article Journal of Real Estate Portfolio Management

Changes in REIT Stock Prices, Trading Volume and Institutional Ownership Resulting from S&P REIT Index Changes

Article excerpt

Executive Summary.

This study investigates the announcement effects of additions and deletions of individual stocks in the S&P REIT Index. The findings indicate a small but significant stock price reaction to additions. However, an addition or deletion has no impact on trading volume and institutional ownership. Overall, there is but limited opportunity for institutional investors to earn abnormal returns around changes in the REIT Index because of trading costs and other incidental expenses. However, individual investors may be able to exploit the arbitrage opportunity if their trading costs are lower. Finally, significant long-term valuation gains following deletions are found-apparently, deletions serve to discipline managers to improve performance.

Introduction

Modern Portfolio Theory has demonstrated the importance of diversification in selecting an optimal portfolio. The low historical correlation between real estate assets and the broader market indices makes them desirable in any portfolio.1 In order to afford a broad spectrum of investors the opportunity to own commercial real estate, the United States Congress created Real Estate Investment Trusts (REITs) in 1960 as an investment vehicle. As added inducement for institutional investors, the regulatory structure of REITs was designed to maximize distribution by mandating high dividend payments, and facilitate pure play strategies by limiting REIT investment choices to real estate assets.2 These factors, in conjunction with the liquidity of REITs over real property has proven to be the primary attraction for including them in portfolios, and have led to the large investor following and tremendous growth of this market sector over the last ten years. Over the period 1990 to 2005, the number of traded equity REITs has increased from 58 to 152, with the total equity market capitalization of REITs increasing from $7.6 billion to $312 billion.3

The growing popularity of and market interest in REITs has been recognized by Standard and Poor's (S&P). In 1997, S&P created an exclusive REIT index called the S&P REIT Composite Index. The REIT Index consists of 100 REITs and covers over 89% of the securitized U.S. real estate market.

Further confirmation of the significance of the size and nature of the REIT industry came within years of the creation of the REIT Index, when on October 9, 2001, S&P announced that six REIT stocks were to be added to the general S&P 400, 500 and 600 indices for the first time. Coincidentally, during the same period of time, the academic research of REITs gained momentum. Fruitful results and useful insights are discovered in the areas such as corporate governance, capital structure, dividend policy and more.4

One of the issues that has attracted considerable interest from academics and practitioners alike is S&P's decision to make changes in its indices. Many of the changes are involuntary when firms are dropped from the indices due to liquidation, merger and acquisition, and major restructuring. Other changes are discretionary when firms are dropped due to sustained poor performance or lost status in the industry. Current literature focuses on the announcement effects associated with additions and deletions of the popular indices, such as the S&P 500, which is a value-weighted index of the most widely traded five hundred stocks in the U.S. exchanges. This interest stems from mainly two sources. First, the S&P 500 Index is tracked by a large group of index mutual funds (i.e., Vanguard S&P 500 Index Fund). To minimize the "tracking error" or the difference between their fund's return and the return on the Index over any period, managers of index funds are interested in the index stocks and must add the stock to their portfolio as soon as it is included in the Index. This causes heavy index fund trading around the time of the change that can move stock prices temporarily out of their equilibrium values. …

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